Contents
Genuine Parts Company (GPC) released Q2 2019 results on July 18, 2019. Guidance for FY2019 has been lowered and corrective action is being taken to improve results.
Summary
- A continued increase in the average age of vehicles and in continued miles-driven growth should act as a tailwind to GPC’s auto-parts division.
- The automotive and industrial parts industries should consolidate around larger industry participants due to their superior levels of component availability.
- Factors such as the weather and fuel prices can meaningfully impact short-term demand for GPC’s products.
- Management is not pleased with recent results. A multi-year project to optimize the portfolio so as to be well positioned for sustained long-term growth is organizational restructuring the consolidation of facilities is currently underway.
- Following the release of Q2 2019 results, lowered FY2019 guidance, and a pullback in GPC’s share price I view shares are fairly valued.
Introduction
When I analyzed Genuine Parts Company (GPC) in my February 19th article I wrote how GPC had improved its:
- Working Capital
- Working Capital Efficiency
- Compressed Cash Conversion Cycle
and had produced steady and strong cash flows.
At the time of that article, shares were trading at ~$109 and based on FY2019 guidance I came to the conclusion that shares were too expensive for me to increase my position. GPC’s share price subsequently increased to ~$115 in early April at which time I suggested there was reason for caution as I was of the opinion GPC was far too expensive based on guidance.
With the release of Q2 2019 results which fell short of expectations and lowered guidance for FY2019, GPC’s share price has now dropped to ~$96 as I compose this article.
I previously viewed GPC as overvalued but following the drop in the share price and lowered guidance I now take a look at whether GPC represents a buying opportunity for long-term investors.
Investment Thesis
GPC, incorporated on May 7, 1928, is a leading service organization engaged in the distribution of automotive replacement parts, industrial parts and materials, and business products.
In FY2018, business was conducted from more than 3,100 locations throughout North America, Europe, Australia and New Zealand and it employed ~50,000 worldwide.
For a company which operates in a less than ‘sexy’ industry it certainly has managed to reward long-term investors. Looking at GPC’s Investor Day presentation we see:
- Increased sales in 86 of the last 91 years;
- Increased profitability in 75 of the last 91 years;
- 63rd consecutive years of dividend increases.
If we look at the extent to which GPC has rewarded investors relative to the S&P500 over the past ~24 years we see that GPC’s return exceeds that of the S&P500 if dividends were continually reinvested; the S&P500’s return, however, exceeds that of GPC when dividends are not automatically reinvested.
June 4 2019 Investor Day
At GPC’s recent Investor Day management discussed the company’s multi-year efforts to optimize the portfolio so as to be well positioned for sustained long-term growth.
The following are a few key points of this presentation.
GPC expanded its automotive footprint beyond North America and into Australasia 6 years ago. This group has performed very well and has added significant value. Since 2017, GPC has added 45 acquisitions to its portfolio and these acquisitions have generated $3B in incremental revenue.
The majority of these new businesses have represented strategic bolt-on acquisitions but GPC has recently taken advantage of more significant opportunities:
- the entree into Europe in late 2017 via the acquisition of Alliance Automotive and subsequent key strategic acquisitions in 2018 and 2019;
- the recently announced industrial expansion into Australasia with the purchase of the remaining interest in Inenco - GPC had originally purchased a 35% stake in Inenco in 2017 and held the opportunity to acquire the balance of the company at a later date.
In addition to expansionary initiatives, GPC has taken steps to streamline operations. In 2018, it consolidated its electrical business into Motion Industries to build a larger, stronger, and more cost-effective industrial business. In 2019, GPC consolidated several automotive operations representing the in-house supply network in NAPA to a more efficient North American automotive supply chain.
In addition, GPC divested itself of its legacy automotive business in Mexico Auto Todo earlier in 2019 to more effectively focus on the growth potential of the NAPA Mexico model established a few years ago.
GPC’s immediate focus is on the execution of the initiatives to control costs and improve profitability and while GPC has had some success in this regard through our investments in technology and automotive supply and industrial realignments, management has indicated that GPC has yet to fully realize the savings required to outpace the pressures of rising costs and the increase in the spend for necessary investments.
As a result, GPC is accelerating its ongoing cost savings plans and is developing aggressive expense reduction initiatives to more effectively address cost structure, to drive meaningful savings and to ultimately deliver incremental value.
Based on my years of experience this typically involves changes on the personnel front and, not surprisingly, GPC’s management has indicated that it has identified opportunities to restructure and consolidate several functional areas and facilities, reducing both personnel and occupancy cost.
Accompanying these HR changes will be the need to aggressively drive incremental revenue growth by capturing a greater share of wallet from existing customers, securing new business opportunities, driving the digital strategy securing additional bolt-on acquisitions.
Q2 and YTD2019 Financial Results
GPC’s July 18, 2019 Earnings Release can be found here.
Automotive Business
Total sales were a record $4.9B, up 2.3% from Q2 2018. This was driven by a 1.6% comp sales increase, and a 2.7% benefit from strategic acquisitions, net of a 1.5% headwind from foreign currency translation, and a 1.5% impact from the Auto Todo divestiture.
GPC experienced positive sales growth in its commercial and retail segments with management being especially pleased with the strength of sales to the commercial segment, which represents close to 80% of total U.S. automotive sales. While it experienced sales gains across the commercial customers segment, sales to the NAPA AutoCare Centers drove the outperformance.
Sales to AutoCare customers were up 5% as a direct result of the increased focused by GPC’s new management team to drive a greater share of wallet with these strategic customers. Management has indicated that NAPA AutoCare represents the fastest growing customer segment for its U.S. automotive business and is targeted to represent well over 18,000 members in 2019.
Sales in the retail segment were positive but pressured from the wet weather that persisted throughout Q2 and management is of the opinion the retail business will bounce back as the weather normalizes.
The NAPA Rewards Program, which has now reached 10.7 million members, continues to drive additional retail sales and positively impact overall results.
NAPA Canada’s business remains strong but Europe has been a challenge. The mild winter across most of the regions in which GPC operates, disruption of business associated with Brexit, and the overall softening economic environment weighed heavily on core sales and significantly pressured operating results.
In early Q1, GPC’s European management team began to take steps to address these issues by implementing a comprehensive cost saving initiative to mitigate the effects of this downturn and ramping up these ongoing efforts continues.
In early June, GPC completed the acquisition of Dutch based PartsPoint Group. This new business is an excellent strategic fit for Alliance Automotive Group (AAG), GPC’s wholly-owned automotive distribution company based in London, U.K. and management is optimistic about growth opportunities in the Netherlands and Belgium, a region of Europe which has not been impacted by the economic and political factors affecting much of Europe; GPC expects PartsPoint to generate ~$0.33B in annual revenue.
GPC also recently announced that AAG has entered into an agreement to acquire the Todd Group, a leading distributor in France for heavy-duty and truck parts and accessories for the independent heavy-duty aftermarket. The European heavy-duty market has avoided the economic and other pressures in Europe and continues to grow at solid rates. Following the closing of the Todd acquisition (closing is anticipated in Q4 and $0.085B in estimated annual revenue is expected), AAG will become the leader in the independent heavy-duty aftermarket in France with over 300 total locations.
Industrial Parts Business
This business generated $1.7B in sales, up 4.9%, including 3.1% comp sales growth, and a 2.1% benefit from acquisitions, which was partially offset by a slight currency headwind. Q2’s sales growth drove improved profitability and a 30-bps improvement in operating margin.
12 of 14 major product groups posted sales gains with especially strong results in the industrial supplies, material handling, and hose and pumps category.
9 of the top 12 industries in which GPC competes generated sales increases. Strong growth was evidenced across several sectors, including iron and steel, fabricated metal products, chemicals and allied products, aggregate and cement, food products, and automotive sectors. Softer sales, however, were evidenced in the electrical specialties group, primarily driven by the impact of lower copper pricing. In a nutshell, GPC remains confident in the growth outlook for its North American industrial business for the balance of the year.
GPC expanded its industrial footprint into Australasia with the purchase of the remaining 65% stake in Inenco, effective July 1. GPC had originally purchased a 35% stake in Inenco in 2017 and held the opportunity to acquire the balance of the company at a later date.
Inenco, is already one of Australasia's leading industrial distributors with operations in Australia, New Zealand, Indonesia and Singapore and total annual sales of ~$0.4B.
Business Products Group
This business represents such a small component of GPC’s overall business that I will restrict my comments to the extent where S.P. Richards reported a slight drop in total and comp sales.
FY2019 Guidance
As a result of Q2 challenges GPC now expects diluted EPS of $5.42 - $5.52 which accounts for the transaction and other costs incurred through the first 6 months of 2019. Adjusted diluted EPS has also been lowered to $5.65 - $5.75 from the previous guidance of $5.75 -$5.90. This represents a $0.15- $0.20 change in earnings before a ~$0.05 contribution from the PartsPoint acquisition and the additional 65% investment in Inenco.
Credit Ratings
GPC’s debt is not rated by the ratings agencies. We see from the following chart, however, that GPC has negotiated credit facilities at very attractive interest rates. Looking at the approximate maturities under the Company’s credit facilities, I am comfortable that GPC should not encounter an issue in repaying the balances due over the next 5 years.
Source: GPC 2018 10-K
Valuation
When I initiated a position in GPC on July 24, 2017, GPC was trading at $82.71 and management had just indicated on its Q2 2017 conference call with analysts that its full year adjusted EPS outlook was being revised downward to $4.70 - $4.75 from its previous guidance of $4.75 - $4.85. I decided to err on the side of caution and used $4.70 to arrive at a forward adjusted PE 17.60.
FY2018 guidance at the time called for adjusted EPS of ~$5.15 thus giving me a forward adjusted PE of 16.07; actual FY2018 adjusted EPS came in at $4.71/share.
When I wrote my April 19, 2018 article, GPC was trading at ~$88.15. Based on management’s $5.60 - $5.75 FY2018 adjusted diluted EPS projection, GPC’s forward adjusted PE range was ~15.3 - ~15.74.
By the time I wrote my July 20, 2018 article GPC’s stock had jumped ~$98 and with no change to adjusted diluted EPS guidance I arrived at a forward adjusted PE range of ~17 - ~17.5.
In my February 19, 2019 article where I looked at FY2018 results I noted that GPC had generated $5.50 in diluted EPS and $5.68 in adjusted diluted EPS for the year. Shares were trading at ~$109 thus resulting in a diluted PE of ~19.82 and an adjusted diluted PE of ~19.2.
At the time of that article FY2019 guidance called for diluted EPS of $5.75 - $5.90 ($5.825 mid-point) or an adjusted $5.81 - $5.96 ($5.885 mid-point). Using the then current ~$109 share price and the mid-points I arrived at a forward diluted PE of ~18.71 and forward adjusted diluted PE of ~18.52.
Under the FY2019 Guidance section of this article I indicated that GPC’s Q2 2019 Earnings Release now calls for diluted EPS of $5.42 - $5.52. Previous adjusted diluted EPS guidance of $5.75 - $5.90 (excludes any first half and future transaction and other costs) has also been lowered to $5.65 -$5.75.
With GPC trading at ~$96 as I compose this article on July 19th we now see that the forward diluted PE range is ~17.4 - ~17.7 and the forward adjusted diluted PE range is ~16.7 - ~17.
As we can see, this forward valuation is certainly more attractive than at the time of my previous couple of articles but not yet as appealing as at the time of my April 19, 2018 article.
Dividend, Dividend Yield, and Dividend Payout
GPC’s dividend history can be found here and its stock split history can be found here.
With GPC now trading at ~$96, the $3.05 annual dividend ($0.762/quarter) provides investors with a ~3.17% dividend yield. At the time of my February 19, 2019 article GPC’s forward dividend yield was ~2.8%; the dividend yield was ~3.26% at the time of my April 19, 2018 article and ~2.9% at the time of my July 20, 2018 article.
With the downward revision in FY2019 earnings to $5.42 - $5.52 we now have a projected dividend payout ranging from ~55.25% - ~56.2% versus ~51.7% - ~53% when guidance was $5.75 - $5.90. Not encouraging but not a reason to be alarmed.
On page 151 of 161 of GPC’s May 29, 2019 Investor Day presentation we see that GPC has prioritized its capital allocation as follows:
- Reinvest in Businesses
- Acquisitions
- Dividends
- Share Repurchases
When we look at page 19 of 87 in the 2018 10-K we see that the weighted average common shares outstanding during year (assuming dilution) has dropped from 154,375 million shares in FY2014 to 147,241 million in FY2018. This share count has been further reduced as at the end of Q2 2019 with the weighted average common shares outstanding having been reduced to 146,029 million shares.
Final Thoughts
Following the release of lowered guidance for FY2019 and the accompanying pullback in GPC’s share price I now view GPC as fairly valued. I do, however, think the overall North American markets are due for a pullback within the next few months and highly suspect GPC’s share price will be caught in any downdraft.
As much as I view GPC as a solid long-term investment I am not looking to aggressively increase my GPC exposure; I continue to automatically reinvest the quarterly dividend income. I am patiently waiting for a broad market pullback so I can increase my position in other existing holdings (eg. Visa (V), Mastercard (MA), the Brookfield companies, Broadridge (BR), Church & Dwight (CHD) etc.).
I hope you enjoyed this post and I wish you much success on your journey to financial freedom.
Thanks for reading!
Note: I sincerely appreciate the time you took to read this article. Please send any feedback, corrections, or questions to [email protected].
Disclaimer: I have no knowledge of your individual circumstances and am not providing individualized advice or recommendations. I encourage you not to make any investment decision without conducting your own research and due diligence. You should also consult your financial advisor about your specific situation.
Disclosure: I am long GPC.
I wrote this article myself and it expresses my own opinions. I am not receiving compensation for it and have no business relationship with any company whose stock is mentioned in this article.
